3 INTERNATIONAL TRADE POLICY

TU-91.2043 International Economics 3 INTERNATIONAL TRADE POLICY

3. INTERNATIONAL TRADE POLICY • 3.1 Free Trade Versus Protectionism • 3.2 Tariffs and Production Subsidies • 3.3 Other Commercial Policies 4 International Trade Policy - 4.1 Free Trade Versus Protectionism

Up to this point, we have explored the benefits ofunrestricted international trade. BUT Governments do restrict free international trade in order to protect domestic industries from foreign competition. The restriction of international trade is calledprotectionism. 4 International Trade Policy

Protectionism is thriving and ‘could hit growth’by Kiran Moodley | Assistant Producer, CNBC.comSept.2, 2013 • Trade protectionism has continued to increase across the world over the last year, with over 150 new trade restrictions created and almost 700 introduced since October 2008, according to a report by the European Commission • adoption of highly trade-disruptive measures, such as those applied directly at the border in the form of import duty hikes • "All of us need to stick to our pledge to fight back against protectionism. It is worrisome to see so many restrictive measures still being adopted and virtually none abolished”, said EU Trade Commissioner Karel De Gucht. "The G-20 agreed a long time ago to avoid protectionist tendencies because we all know these only hurt the global recovery in the long run” • The Commission said that emerging economies had applied the highest number of potentially trade-restrictive measures • Brazil, Argentina, Russia and Ukraine introducing the heaviest tariff increases 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Report reveals mixed results in EU’s fight against protectionismBy Lénaïc Vaudin d’Imécourt | 14 March 2013 The European Commission’s efforts to fight protectionism over the last year bore fruit, the EU executive was proud to announce when releasing the third edition of its ‘Trade and investment barriers’ report, on 14 March. However, the overall assessment of the report, which looks at progress made throughout 2012 on the elimination of 25 key trade barriers in six countries/regions (China, India, Japan, Mercosur, Russia and the US), is a little less positive. While the Commission has indeed achieved some success in removing a certain number of trade distortive measures – one of the most noteworthy examples is the EU’s victory in its WTO case against China on raw materials – not all measures could be satisfactorily addressed - some were even increasing. Between €90 billion and €130 billion worth of EU trade has been affected by these barriers in the past three years, an EU source noted. “There are repeat offenders out there,” trade spokesman John Clancy conceded. “They need to change their positions, remove their barriers to trade and recognise their obligations within the framework of the WTO,” he said. Indeed, according to the 2013 Commission report, barriers remain in India and Russia, and protectionism is even on the rise in Argentina, Brazil and China. 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Protectionism is widely viewed as having deepened and prolonged the Great Depression Smoot-Hawley Tariff Act signed June 1930 raised U.S. tariffs on over 20,000 imported goods to record levels. Some 60 countries retaliated with their own increased tariffs… Monthly value of imports in 75 countries between 1929 and 1933. 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

The Case for Free Trade • We have demonstrated how free trade benefits all trading countries1 • The theory of comparative advantage is the case for free trade • A good/service is not imported unless its net price to the buyer is below that of the domestically produced alternative 1 An exception: Large countries possess monopoly power in international trade. For them free trade is not Pareto optimal (Brazil in coffee and Japan in automobiles, for instance) 4 International Trade Policy - 4.1 Free Trade Versus Protectionism

Later (under Trade Barriers) we will show that: Trade barriers prevent a nation from fully employing the benefits of specialization, push it to adopt relatively inefficient production techniques, and force consumers to pay higher prices for protected products than they would otherwise pay. 4 International Trade Policy - 4.1 Free Trade Versus Protectionism

Freer trade cuts the cost of living According to one calculation, consumers and governments in rich countries pay $350 billion per year supporting agriculture — enough to fly their 41 million dairy cows first class around the world one and a half times. (WTO) 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Yet for hundreds of years the nations of the world have tried hinder the free trade by means of several devices, such as tariffs, quotas, technical or administrative rules and procedures, such as licensing regulations, and exchange control • Such polices are called commercial policies • In general, these policies are influenced by political, social, and economic considerations 4 International Trade Policy - 4.1 Free Trade Versus Protectionism

The Lure of Protectionism • The argument for so-called "protectionism" (called "fair trade" by some) may at first sound appealing • Supporters of "protectionist" laws claim that keeping out foreign goods will • save jobs • give ailing domestic industries a chance to recover and prosper • and reduce the trade deficits • Are these claims valid? • Arguments for protection can be either economic or noneconomic 4 International Trade Policy - 4.1 Free Trade Versus Protectionism

The Case for Protection Common Arguments Against Free Trade: • Protection saves jobs. • Free trade would change income distribution. 3. Some countries engage in unfair trade practices. 4. Cheap foreign labor makes competition unfair. 4 International Trade Policy - 4.1 Free Trade Versus Protectionism

5. Protection safeguards national security. 6. Protection discourages dependency. • Protection safeguards infant industries. 8. Protection provides protection during temporary currency overvaluation. 9. Preserving way of life. 10. Simple way to collect money for government. 4 International Trade Policy - 4.1 Free Trade Versus Protectionism

3 INTERNATIONAL TRADE POLICY • 3.1 Free Trade Versus Protectionism • 3.2 Tariffs and Production Subsidies • 3.3 Other Commercial Policies 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

World economy gains when countries first begin international trade: Comparative advantage based either on a relative advantage in technology or on relative factor abundance, or because different countries specialize in producing different brands when economies of scale exist • ...But this does not mean that everyone will be better off 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Let's give two examples of the conflicts to which international trade can lead: Consider a) Argentina and Brazil starting to export frozen meat to world market. b) The impact of increased foreign car sales in EU on EU car industry. 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Who gained and who lost? • Should government hear out the producers or consumers pleads? • More generally, how should we decide whether to restrict imports or have free unrestricted trade in all goods? 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Next we will consider different commercial policies • We will show how to analyze costsand benefits of tariffs as well as other types of trade restrictions • Doing so we will move from positive economics to normative economics 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Most Common Trade Barriers Trade barriers -obstacles to trade- take many forms, three most common ones are: 1. Tariffs:import duty(a tax on imports) Can also be an export duty, but that is less common. 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

2. Export and Production Subsidies: • Government payments made to domestic firm to encourage exports or production in general • can also act as a barrier to trade • Closely related to subsidies is the practice of dumping • Dumping takes place when a firm or an industry sells products on the world market at price below the cost of production China: US should stop new anti-dumping probe on solar products 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

3. Quotas and Voluntary Export Restraints (VERs): • A limit on the quantity of imports • Can be mandatory or voluntary, and can be legislated or negotiated with foreign governments 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Economics of Tariffs • Tariffs are the most common type of trade restriction • A tariff requires the importer of a good to pay a specified fraction of the world price to the government • By raising the domestic price of imports, a tariff helpsdomesticproducersbuthurts domesticconsumers 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

If the world price is Pw, and there is free trade, domestic firms produce Qs, Pw+ T domestic consumption is Qd Pw and the difference is imported. Qs Qd' Qd Qs' At a domestic price Pw + T, where T is the size of the tariff, and imports fall. quantity of domestic demand falls to Qd', quantity of domestic supply rises to Qs' The Effect of a Tariff Ddom & Sdom show the domestic demand and supply for a good. Sdom Price Ddom A tariff can stimulate domestic production and restrict imports. Quantity 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

We can summarize the effects of tariffs to • Consumption effect • domestic consumers reduce their consumption • Production effect • higher prices make it profitable for domestic producers to increase their output • thus the tariff attracts resources into the protected industry from other sectors of the economy 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

We can summarize the effects of tariffs continued: • Trade effect • the tariff causes imports to fall • Revenue effect • after the imposition of the tariff, the government collects a certain amount of money • Redistribution effect • the tariff redistributes income from consumers to producers 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

The government raises revenue – i.e. there is a transfer to the government, and there is a transfer in the form of extra profits to producers. The tariff leads to a social dead-weight cost from production inefficiency, given that the good could be imported at Pw. The tariff also leads to a dead-weight loss from consumption inefficiency. The Welfare Costs of a Tariff The tariff leads both to transfers and net social losses. Consumer surplus is decreased by the area between Pw+T, Pw and D. S Price But where does this lost of CS go to? Pw+ T Pw D Qs Qd' Qd Qs' Quantity 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Tariffscontinued • The deadweight burden of a tariff suggests that society suffers from restricting trade • This is the case for free trade • Tariffs have fallen substantially under the GATT (General Agreement on Tariffs and Trade) and WTO (World Trade Organization) 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

The case for tariffs – good arguments • When a country's imports form asignificant share of the world market for a commodity, a higher level of imports is likely tobid upthe world price Then an imposition of an import tariff could lead to a welfare improvement for the country, relative to free trade. 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Optimal Tariff • In this case an economy will gain by imposing a tariff, which will restrict the imports until the benefit of the last import equals its cost to society as a whole • Effectively this is a transfer from foreign suppliers, who lose out, to the importing country, which gains 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

An Example of Optimal Tariff • Let’s assume that country A is an economically large country (a large world importer of a product L) • Country B exports product L • Let’s consider the situation under free trade and after an import tariff is imposed by country A 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

PTF is defined byimports = exports Country B has a comparative advantage in production of L. 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Free Trade Equilibrium continued • Free trade equilibrium price, PFT, is defined as the price at which the quantity consumers in A want to import equals the quantity that producers in B want to export • Next suppose that A imposes a tariff on imports of L which causes imports to fall 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

After imposing a tariff country A wants to import only Q4 – Q3. Tariff revenue e is paid (in effect) by producers in B. And country B is willing to sell that amount at price P’. 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Welfare Cost of a tariff Imposed by a large country  in CS  in PS  in G revenue Net welfare change Optimal tariff would max $e - $(b + d) 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Optimal tariff - a first-best argument • This policy fulfils the principle of targeting • which says that the most efficient way to attain a given objective is to use a policy that influences that activity directly • policies that attain the objective, but also influence other activities are second-best, because they distort those other activities 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

The case for tariffs – second-best arguments • Way of life • an attempt to preserve ‘traditional’ ways • a production subsidy would be better 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

The case for tariffs – second-best arguments continued • Infant industries • an attempt to nurture new activities via learning by doing • a temporary production subsidy probably better • Revenue • tariffs raise government revenue • but there are better ways to do that • Cheap foreign labour • a non-argument – denies benefits of comparative advantage 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Comparison of the Effects of Import Tariffs and Production Subsidies • Domestic production can also be increased and imports reduced through the use of a production subsidy • Actually, temporary production subsidies rather than import tariffs are some times suggested by economists WHY? 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

(a) Tariff (b) Subsidy Sdom Sdom Price Price Sdom+ s Sw + t P’ Sw Sw P P Ddom Ddom Qsd’ Qd Quantity Quantity Qs Qs Qsd’ Qd = dead weight loss Let's compare the effects of these two trade restrictions on the welfare of the society 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Although production subsidies are less inefficient in increasing domestic output, they are relatively uncommon because they are politically unpopular • A tariff raises money for the government, but the taxpayers have to provide the funds for the subsidy… 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Thebenefitsof a production subsidyin the form of lower consumer prices are frequentlynot understoodby voters who instead object to the resulting expenditure of the public funds 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

3 INTERNATIONAL TRADE POLICY • 3.1 Free Trade Versus Protectionism • 3.2 Tariffs and Production Subsidies • 3.3 Other Commercial Policies 4 International Trade Policy - 4.3 Other Commercial Policies

Other commercial policies • Although tariff rates have fallen under GATT and WTO, there has been an increase of other trade restrictions • quotas • export subsidies • non-tariff barriers • administrative regulations that discriminate against foreign goods 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Quotas • Even though quotas restrict the quantity of imports, this does not mean they have no effect on domestic prices of the restricted goods • With lower supply the equilibrium price will be higher than under free trade. So quotas affect in a same way as tariffs! 4 International Trade Policy - 4.3 Other Commercial Policies

Types of Quotas • Embargo—complete ban on import of a certain good • Tariff Rate Quota (TRQ)—allows a certain quantity of a good into a country at low or zero tariff rate, but applies higher tariff to quantities exceeding the quota • Voluntary Export Restraint (VER)—an indirect quota resulting from an exporting country “voluntarily” limiting its exports 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Domestic demand and supply of good M Areas b and d represent deadweight costs. How about c, who gets these quota rents? Government, domestic producers/importers or foreign producers (VER)? That is, who gets the licenses! World price of M 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

Export subsidies • "commercial policy to boost exports" Consumption loss Production loss Exports Sdom Price B A Sw+ s P’ G E Sw P F C Ddom Qd’ Qd Qs’ Qs Quantity 4 International Trade Policy - 4.3 Other Commercial Policies

Export subsidiescontinued • Under free trade, domestic consumption is Qd and production Qs and exports are GE. With a subsidy on exports alone, domestic producers will restrict supply to the home market to Qd’ so that home consumers pay P’, the same as producers can earn by exporting. Total output is Qs’, and exports AB. Area EFB shows the social cost of producing goods whose marginal cost exceeds the world price for which they are sold. Area CGA shows the social cost of restricting consumption when marginal benefits exceeds the world price of the good. 4 International Trade Policy - 4.3 Other Commercial Policies

More of Non-Tariff Barriers • delays at border • quality control measures • even standards some times... and The European Union and Canada have responded angrily to the 'Buy American' clause in President Obama's $825bn economic stimulus package. They claim it could lead to protectionist trade practices and help spark a new trade war. Philippa Thomas reports from Washington 3 February 2009 Will 'buying American' cause more harm than good? 4 International Trade Policy - 4.3 Other Commercial Policies

Conclusion Trade protection is usually harmful to the society. Yet governments frequently adopt it because it is a politically easy option. 4 International Trade Policy - 4.2 Trade Barriers: Tariffs, Subsidies and Quotas

3 INTERNATIONAL TRADE POLICY